3.Pique Corporation wants to purchase a new machine for $300,000. Management pre

Question

3.Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

What is the net present value (NPV) of the investment? (The PV annuity factor for 5 years, 10% is 3.791.) Assume that the cash inflows occur at year-end.

Explanation / Answer

Project NPV

The net present value approach is the most intuitive and accurate valuation approach to capital budgeting problems. Discounting the after-tax cash flows by the weighted average cost of capital allows managers to determine whether a project will be profitable or not.

NPV= {Periodical Cash Flow / (1+R)^T} - Initial Investment

Here,

Initial Investment = $300,000

After Tax rate of Return = 10%

Time Period = 5 Years

Periodical Cash Flow :-

Particulars

Amount

Revenues

$ 200,000.00

Expenses

$   80,000.00

Depreciation

$   60,000.00

Net Profit before taxes

$   60,000.00

Tax @ 40%

$   24,000.00

Net Profit after taxes

$   36,000.00

Depreciation

$   60,000.00

Cash Flow after taxes

$   96,000.00

Present value of the Cash Flow after taxes = Cash Flow X PVAF of 10% for 5 Years

= $96,000 X 3.791

= $ 363,936

NPV = Initial Investment – PV of cash Flow

NPV = $363,936 – $300,000

NPV = $63,936

Particulars

Amount

Revenues

$ 200,000.00

Expenses

$   80,000.00

Depreciation

$   60,000.00

Net Profit before taxes

$   60,000.00

Tax @ 40%

$   24,000.00

Net Profit after taxes

$   36,000.00

Depreciation

$   60,000.00

Cash Flow after taxes

$   96,000.00

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